Coming to Terms: Important Issues and Considerations in Drafting M&A Agreements — Part I: Economics
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Earlier this month, I posted a brief overview blog regarding the drafting and negotiating of the purchase and sale agreement in an M&A deal. This blog on the economic terms in the agreement will begin a series on the most important terms in the agreement. This blog will be followed by two, detailing the representations and warranties provisions, and the indemnification provision.
What drives the deal is ultimately the money. The purchase and sale agreement will describe the final economic terms of the transaction, likely described in summary form, but in no required detail, in the letter of intent. You can expect the definitive agreement to spell out in detail:
- The exact description of what is being bought (i.e. the company’s stock or its assets, etc.)
- Any liabilities to be assumed by the acquirer;
- The total consideration to be paid by the acquirer;
- The form of the consideration (cash, a promissory note, acquirer stock, a combination thereof, etc.);
- How any earn-outs will work;
- Any conditions to closing; and
- What documents will be exchanged at the closing.
- Assets/interests to be sold
The buyer’s draft of the purchase agreement should accurately describe what is actually being purchased by the buyer (the specific assets in an asset deal or the stock or other ownership interests in a stock deal) and those assets or liabilities being retained by the seller, if any. Hopefully, there is agreement on such big picture terms prior to receipt of the purchase agreements so that there will not be lots of negotiation on these points.
The seller will want to be sure all of the descriptions are correct. In particular, in an asset deal, be sure all assets you intend to remain with you (“excluded assets”) are specifically listed. Typical excluded assets are cash, marketable securities, assets associated with retained liabilities (e.g. 401(k) assets if the plan is being retained), and often certain personal assets (e.g., the seller’s vehicle). Generally, the buyer will draft very broad language when describing the transferred assets, such as “all assets used in the business, including…” Therefore, it is up to the seller to carve out assets that should not be transferred.
On the liability side, be sure all liabilities that the buyer will take are listed (here, the buyer’s purchase agreement will usually use very restrictive language such as “seller retains all liabilities and obligations except for the following: [list of specific liabilities]”). Typical liability that the buyer will assume include obligations under assigned contracts and accounts payable. This is only relevant in an asset deal.
A stock deal is typically simpler to describe but be sure the description of stock or other interests being purchased and sold is correct.
- Purchase price
Often, the purchase price terms will be one of the first subsections of this section. It should include (i) the portion of the purchase price to be paid at the closing and how it will be paid (e.g. $5,000,000 by wire transfer to a bank account of the seller), (ii) any portion of the purchase price to be paid via delivery by the buyer of a promissory note to the seller (e.g., $2,000,000 by delivery of the buyer’s promissory note to seller), and (iii) any portion to be paid via an earn-out. Many times there are potential adjustments to the purchase price too (e.g., working capital adjustments), some of which may be made at the closing and others which are made post-closing. Such adjustments should also be very clearly described.
The “closing” should be defined and described in the purchase agreement. Most deals now close by exchange of documents by electronic transmission with originals to follow by overnight mail. A specific date for the closing should be set, especially in a deal that will provide for signing of the purchase agreement before the closing. Also, it is common to set the effective time for the closing (e.g., 11:59pm on the date of closing), to eliminate any confusion about events that occur or conditions that apply on the “closing date” but before or after the “closing” itself.
Probably the most important provision of the purchase and sale agreement considering the money is what drives the deal, the economic provision must be detailed and, written with specificity and accuracy. The next blog will cover, in detail, the representations, warranties, and disclosure schedules.